I did an article on young Warren Buffet’s investment in Sanborn Maps.
This had been a very successful mapping monopoly.
Sanborn Map sold building and neighborhood maps to insurance companies, which used them for fire risk assessment. Mapping out the entire US was labor-intensive operation but it was very profitable.
However, this previously successful, labor-intensive approach to fire risk assessment was being replaced over time by a more technological approach. And Sanborn Map had been a long but steady decline, in revenue, profit margins and net income. And the share price had dropped from $110 in 1938 to $45 in 1958, when young Warren Buffett started buying shares.
Buffett eventually bought 23% of the company at around $45 per share. His goal was to get access to Sanborn’s stock and bond portfolio, which was worth $65 per share. It was a classic Ben Graham approach based on liquidation value. At the time Buffett investment, Sanborn’s market capitalization was $4.75M but its stock and bond portfolio was worth $7M. Buffett bought based on liquidation value and then went activist to liberate that value.
As I was looking at this case, I realized I had seen Buffett do this type of investment many times. I call them his investments in “slowly dying” or “predictable death” businesses.
Why Sanborn’s Slow but Predictable Death Was an Investment Opportunity
By the 1950’s, previously successful and cash rich Sanborn was in serious decline. From the 1930’s to the 1950’s, annual profits had fallen from $500,000 to just $100,000. This was mostly due to three factors:
- Insurance company consolidation. Sanborn was getting +90% of its revenue from about 30 insurance companies. Over time, these companies consolidated. This put pressure on Sanborn’s high prices. And it also reduced sales volume. Merged companies didn’t need two subscriptions to Sanborn’s maps.
- Buildings and cities got better and safer. As building materials and building codes improved, fire risk in cities decreased. Plus, fire stations got better at putting them out. Major fires in cities became much less common.
- Technology created a low-cost substitute for risk assessment. In other types of insurance, companies used a “carding” system, where every building had its own card record. This approach was more based on data and algorithms than labor-intensive surveys. This technology eventually expanded to fire insurance and fire risk maps eventually disappeared.
Dying businesses are an important pattern to recognize.
- A good or great company is created and grows in revenue and market share.
- Eventually, it dominates a market and generates significant returns. Which often result in bloated balance sheets and lazy management.
- Eventually, demand changes and/or competitors take them down, usually with a new technology.
- The dying but previously successful company often has a lot of assets on the balance sheet. And managers who want to keep their jobs, despite knowing their business is dying.
Buffet saw a dying business. It wasn’t just shrinking. It was going to cease to exist. You can say the same thing about print newspapers today. In the future, they won’t be around as products.
What made Sanborn interesting was that its death was both slow and predictable. It wasn’t happening fast. It wasn’t in a cash crisis. Its death was slow and predictable, which means the stock markets priced that future in. That predictability made the price low and gave Buffett his opening. He bought in cheap, went activist and liberated some of its liquidation value. He got the last two puffs of the cigarette butt really cheap.
The Slow but Predictable Death of Dempster Mills Was Another Buffett Opportunity
In 1961, Buffett invested in Nebraska-based windmill company Dempster Mills. Like Sanborn, it was a previously successful company that was now in terminal decline.
Dempster Mills had been founded in 1878 as the American Midwest and the Great Plans were being settled. And these settlers needed water pumps and windmills for their agriculture. Dempster began as a retailer and distributor of windmill and irrigation systems in Omaha. And eventually began producing their own products around 1885. At the time, windmills were the primary power source for water pumps. They moved the water through the irrigation systems, which were used for feeding livestock and other essential farm operations.
However, by the 1960’s the demand for windmills and related equipment was in serious decline. The electrical grid had reached the rural Midwest and electricity-driven pumps were replacing wind power water sources. Electrical pumps were just a superior technology. For example, they could, unlike wind, be turned on and off as needed.
Buffett started buying shares in 1956 and by 1961 had 70% ownership (plus another 10% through associates). Unlike Sanborn, this business did not have a stock and bond portfolio that could be liquidated. What it had was two business lines.
- Sales of new equipment.
- Sales of spare parts and services.
Both business lines were in terminal decline. This was a dying business. But it was happening in a predictable manner. And the second business line (spare parts and services) was falling much slower than the first. They also had a business selling agriculture equipment, such as seed drills and fertilizer applications.
We see some similarities to Sanborn.
- The business was dying. It was certain.
- But it was happening slowly and in a predictable manner.
- It was also not losing money or in crisis.
Businesses that are losing money tend to die fast. Or be unpredictable. But businesses that are shrinking as their demand disappears can still be at operating breakeven. It is a gradual decline.
That was the case with Dempster. And in this case, Buffett was going to get his return by liquidating the inventory and accounts receivable, which were substantial.
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Note: Much of the Sanborn and Dempster Mills information in this article are from Yefei Lu’s book Inside the Investments of Warren Buffett.
Buffett and Competitive Advantage Are About Predictability
I’ve written 7 books about competitive advantage. And this is usually about identifying great companies. And great companies is what Warren Buffett usually talks about.
But it’s not really.
Competitive advantage is about predictability. Businesses with moats are protected from competitor actions. That makes their future much easier to predict. It can change with customer demand and behavior. Or technology. Or regulation. But it has some degree of protection from the most rapidly changing factor, which is competitor actions.
I think Warren Buffett thinks about business this way. He thinks about predictability. For his early career, he was investing in businesses that sucked. But they were predictable. In this case, these were predictable in their death.
In his later career, he started buying great companies. But these were not great like Google or Facebook, with stratospheric returns. They were great like Coca-Cola, with steady predictable gains in economic value per share.
For all the talk about great companies, it’s easy to forget that you can make money on dying companies as well. As long as it is predictable.
The Problem with Dying Companies Is Usually Management
In both of these companies, there was significant, unrealized value in slowly dying business. And in both cases, the problem was management behavior.
Executives at dying businesses can do all sorts of crazy behavior. They can do acquisitions. They can launch expensive new initiatives. They can try to pivot. The one thing they don’t like to do is to close their businesses and reallocate the capital elsewhere. That puts them out of their jobs. And senior executives have usually spent their career getting to the top. They don’t like to fire themselves at the peak of their careers.
That’s when you need activist shareholders to get involved. Which Warren Buffett did in both cases. They represent shareholder (not management) interests and liberate the unrealized value (for shareholders).
Buffett would later do the same thing with his purchase of Berkshire Hathaway, a dying men’s clothing manufacturer in Massachusetts. He saw that competition from Asia was going to make the business non-viable. He took over. And then he stopped management from doing any re-investment. He began to redeploy its capital into other businesses. He eventually closed Berkshire and kept the name.
Corporate raiders (later called activists) like Carl Icahn really ran with this playbook in the 1980’s. Icahn symbolized the era, having been gifted with a pit bull’s personality and a chess master’s brain. Icahn is scarily effective at taking on entrenched management acting in their own self-interest (in his opinion).
But it’s worth pointing out that young Warren Buffett had been doing the same playbook +30 years prior.
Final Point: Warren’s “Slowly Dying” vs. Munger’s “Cancer Patients” vs. Alwaleed “On their Knees” Businesses
Buffett seems to like “slow but predictable death” businesses for investments. In fact, in the past decade he has been buying into print newspaper businesses. Which he says will definitely be gone one day.
That is a bit different than the “cancer patient” businesses that his partner Charlie Munger used to talk about. These are businesses that are in decline (which everyone can see so the price goes down). But they are not definitely dying. In this case, only one part of the business has the problem. So, you can buy it and then cut out the dying part (basically, like cutting out a cancer). The rest of the business is then fine.
Another variation that comes to mind is how my old boss Prince Alwaleed who used to like to buy companies that were “on their knees”. He mostly did private deals so he was looking for good businesses where the owners (for some reason) were looking to make a sale. Such as a high-quality bank that had a short-term liquidity problem and had cash flow negative. That was how he became the largest shareholder in Citibank in the 1990’s. There was nothing wrong with the company. It just had a liquidity problem. He would describe this is as a good business “on its knees”. I heard him use that phrase over and over through the years. For Citibank, he injected cash and it was soon back to normal.
He did the same approach with Euro Disney, Apple, Samba, Canary Wharf and many other businesses.
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Anyways, these are interesting businesses to look at. I always start with an assessment of the business itself.
- Is it definitely dying? (a Buffett Slowly Dying Biz)
- Is just part of it dying? (Munger’s Cancer Patient)
- Is it fine but just has a temporary problem? (Alwaleed’s On Its Knees Biz)
Cheers, Jeff
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From the Concept Library, concepts for this article are:
- Activist Investing (Ques 5): Buffett’s “Slow But Predictable Death” Biz
- Activist Investing (Ques 5): Munger’s “Cancer Patient” Biz
- Activist Investing (Ques 5): Alwaeed’s “On Their Knees” Biz
From the Company Library, companies for this article are:
- Sanborn Map Company
- Dempster Mills
- Warren Buffett / Berkshire Hathaway
Photo by Mathias Reding on Unsplash
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I write, speak and consult about how to win (and not lose) in digital strategy and transformation.
I am the founder of TechMoat Consulting, a boutique consulting firm that helps retailers, brands, and technology companies exploit digital change to grow faster, innovate better and build digital moats. Get in touch here.
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